Precious Metals: How to Form Protective Part of the Portfolio

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Precious Metal Investing

How to invest in precious metals and why investors buy gold during a crisis – we will tell you in this article.

Having faced the crisis, investors start stocking up on precious metals, since these tools are backed by a specific commodity. The probability that the cost of metals will approach zero point is hardly imaginable, so the risk of losing all the money invested is too small.

The most popular precious metals are gold, silver, palladium and platinum. They are divided into 2 groups:

  • Gold;
  • Industrial precious metals.

Gold

Traditionally, gold is considered a value-preserving asset: in most cases, this metal is invested in to save money, not increase. Gold bars can last for centuries and do not rust, so their value does not diminish over time.

Gold is bought not only by private investors, but also by the reserves of world banks. They replenish gold reserves to withstand the crisis, when prices for other investment instruments will fall.

Where is gold used? Half of the global demand is jewelry, another 40% is investment demand. Industrial demand is only 10%, gold is mostly used in the production of electronics.

Industrial precious metals

Palladium buys the auto industry and makes devices from this metal that purify exhaust gases. The public is becoming more and more demanding of the “environmental” of cars, so automakers are increasing the amount of this metal in cars, which means that the demand for palladium will grow. Until 2024, analysts predict a deficit in the palladium market.

Platinum, like palladium, is used in the auto industry. In other industries, platinum is used at some stages of oil refining, in the production of nitrogen fertilizers. Unlike palladium, platinum is a high-grade precious metal and is used in jewelry.

Silver. As an industrial material, silver is used in electronics, chemistry, medicine, and the military industry. It is also used for making jewelry.

How to invest in precious metals

  1. Bullion. You can buy a pure metal bullion in the bank. When buying, you need to pay VAT to the state and also to the bank for storing the bullion in the cell. The main disadvantage of investing in physical metal is low liquidity. You can sell a bullion to a bank, jeweler, pawnshop or to a professional gold dealer like Pacific Precious Metals where you can sell or buy gold, platinum and other precious metals.
  2. Coins. Investment coins can be bought at the bank, you do not need to pay VAT. Bars and bullion coins need to be cared for properly, otherwise the metal may oxidize and its value will decrease.
  3. Mutual Funds and ETFs. You can buy securities of mutual funds (mutual funds) or ETFs (exchange traded funds) that invest in gold on a brokerage account.
  4. Mining companies’ shares. The share price depends on the prices of precious metals, but also on the reputation of the company, its financial performance, and the general news background. Many companies pay dividends – a portion of the profits that the issuer donates to its shareholders. To invest in mining stocks, you need to open a brokerage account and access the exchange.
  5. Futures contracts. This investment instrument is suitable for professional traders who speculate in the market. By buying a futures contract for a precious metal, you agree to redeem the goods from the seller at a pre-agreed price. If the market price on the date of execution of the contract turns out to be higher than the futures price, then the buyer earns: he takes the goods and receives the difference.

Rules for investing in precious metals

  1. Form a protective part of your portfolio out of precious metals. Diversify your portfolio. Invest 10-15% in precious metals – and this will be the protective part of your portfolio. It is pointless to increase the share, because gold and other metals are an asset that does not generate cash flow, unlike stocks or bonds. With its help, you can temporarily protect your money from inflation or wait out the volatility in the market, but not get income.
  2. Trade in precious metals should be situational. Increased demand for gold is formed in conditions when risk-free rates (for example, on US government bonds) begin to fall below expected inflation. When trading in industrial precious metals, pay attention to the balance of demand from consumers and supply from manufacturers. Conduct a market surplus/deficit assessment and analyze the size of available stocks.
  3. Long-term investment. In the context of a hundred-year history, precious metals outstrip inflation, but fluctuations during the day are quite high. Therefore, it is worth investing in precious metals for the long term – 10-15 years.

Why do investors buy gold during a crisis?

In the era of the gold standard, when each currency could be exchanged for a certain amount of gold, this noble metal was considered a guarantor of the preservation of value. Since then, gold has secured the status of a defensive asset.

In the 21st century, the situation is changing. The demand for gold during the economic downturn persists, but this market, due to its limited size (there is a limited amount of metal circulating on the market), is not able to “accommodate” everyone.

The 2020 crisis, the worst economic downturn since the Great Depression, did not push the metal to new all-time highs. Precious metals will remain protective instruments for a long time, but each time the reaction of quotations to the crisis may be less sensitive.

The real cost of gold is below $1000, and the profitability of gold mining companies is unfairly high. The growth of quotations is justified by the expectations of investors (everyone is used to the fact that with the next crisis the demand for metal should increase), and not by the real need for physical metal.

How do metal prices change during the crisis? When interest rates fall, inflation rises and a crisis approaches – the price of gold rises and, to a lesser extent, silver. Platinum and palladium as industrial metals during such periods can be under pressure. This is exactly the situation that was observed in February-March 2020.

Conclusion

Each investment option has its own advantages and disadvantages. You just need to choose the right tool based on your personal capabilities, personal financial goals and risk tolerance.